On June 18th 2018, the Luxembourg government published a draft law implementing the first Anti-Tax Avoidance Directive (hereafter “ATAD”) into Luxembourg law (please see our Newsletter of April 2016 on the topic of the ATAD). The draft law still needs to go through the Luxembourg legislative process and may be subject to amendments before the final vote by the Luxembourg Parliament. As a general theme, where options and opt-outs were provided by the ATAD, the Luxembourg government decided to implement the most favourable options.
The draft law provides, starting January 1st 2020, for the taxation at market value of the assets transferred upon change of tax residency, upon transfer from the domestic head office to a foreign permanent establishment, upon transfer from a domestic permanent establishment to a foreign permanent establishment or head office. The same rule would apply to transfers of complete activities from a domestic permanent establishment to another country. The above only applies in cases where Luxembourg loses taxation rights over said transferred assets or activity. In case the above transfers occur within the European Union or to an EEA country with which Luxembourg concluded a mutual assistance agreement, the taxpayer may pay the exit tax by instalments over a maximum of 5 years.
Controlled foreign company (hereafter “CFC”) rules
These rules aim at reallocating undistributed income of 50% owned subsidiaries or permanent establishments (hereinafter “PE”) to the parent company, even when no income has been distributed. The parent company will then have to pay corporate income tax on the income of the subsidiary pro rata to its ownership or control of the subsidiary (or PE). Luxembourg took the option to limit the application of the CFC rules to non-genuine arrangements. As from January 1st 2019, Luxembourg will therefore tax the non-distributed income of a subsidiary or PE which qualifies as a CFC, solely if the non-distributed income arises from non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage. In case a subsidiary or a PE is deemed as non-genuine, Luxembourg will solely include the income that was generated from assets and risks that are linked to the important functions performed by the parent company that controls the subsidiary or the PE in accordance with transfer pricing rules. In addition thereto, a subsidiary or PE will not qualify as a CFC in case (i) its accounting profits do not exceed EUR 750,000 or (ii) the accounting profits do not exceed 10% of the operating expenses.
Interest limitation rules
The draft law proposes to limit, as of January 1st 2019, the deductibility of net borrowing costs (i.e. the interest expenses that exceed interest income) to 30% of the taxpayer's fiscal EBITDA (Earnings before Interest, Tax, Depreciation and Amortisation) with a de minimis exception if the net borrowing costs do not exceed EUR 3 million. Standalone entities as well as some financial undertakings are expressly excluded from the scope of the interest limitation rule. Additionally, taxpayers who can demonstrate that their equity ratio is equal to or lower than the ratio of the consolidated group they belong to can, subject to certain conditions, fully deduct the net borrowing costs. Lastly, loans issued before June 17th 2016 will be grandfathered and remain out-of-scope of the present limitation, unless they are modified after that date.
Hybrid mismatch rule
Hybrid mismatches could result from different tax characterisation of a financial instrument or an entity between different countries. According to the anti-hybrid mismatch rule, an expense will become non-deductible in Luxembourg either when (i) the same expense has already been deducted in another Member State of the European Union or (ii) the expense is not included in the taxable result of the counterparty resident in another Member State of the European Union. In practice, a Luxembourg resident taxpayer will have to be able to demonstrate, upon request, that no deduction without inclusion or no double deduction took place (e.g. by producing tax certificates issued by other Member States or copies of the foreign tax returns).
General anti-abuse rule (hereafter “GAAR”)
As from January 1st 2019, the domestic abuse of law concept will be replaced with the GAAR included in the ATAD. This will allow Luxembourg to ignore an arrangement or a series of arrangements, when computing the tax liability of the taxpayer, provided they have been put into place for the main purpose, or as one of the main purposes, of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, being not genuine having regard to all relevant facts and circumstances. An arrangement, which may comprise more than one step or part, is regarded as non-genuine to the extent it has not been put in place for valid commercial reasons which reflect economic reality.